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The slope of an AS curve changes from nearly flat at its far left to nearly vertical at its far right. At the far left of the aggregate supply curve, the level of output in the economy is far below potential GDP    , which is defined as the quantity that an economy can produce by fully employing its existing levels of labor, physical capital, and technology, in the context of its existing market and legal institutions. At these relatively low levels of output, levels of unemployment are high, and many factories are running only part-time, or have closed their doors. In this situation, a relatively small increase in the prices of the outputs that businesses sell—while making the assumption of no rise in input prices—can encourage a considerable surge in the quantity of aggregate supply because so many workers and factories are ready to swing into production.

As the quantity produced increases, however, certain firms and industries will start running into limits: perhaps nearly all of the expert workers in a certain industry will have jobs or factories in certain geographic areas or industries will be running at full speed. In the intermediate area of the AS curve, a higher price level for outputs continues to encourage a greater quantity of output—but as the increasingly steep upward slope of the aggregate supply curve shows, the increase in quantity in response to a given rise in the price level will not be quite as large. (Read the following Clear It Up feature to learn why the AS curve crosses potential GDP.)

Why does as cross potential gdp?

The aggregate supply curve is typically drawn to cross the potential GDP line. This shape may seem puzzling: How can an economy produce at an output level which is higher than its “potential” or “full employment” GDP? The economic intuition here is that if prices for outputs were high enough, producers would make fanatical efforts to produce: all workers would be on double-overtime, all machines would run 24 hours a day, seven days a week. Such hyper-intense production would go beyond using potential labor and physical capital resources fully, to using them in a way that is not sustainable in the long term. Thus, it is indeed possible for production to sprint above potential GDP, but only in the short run.

At the far right, the aggregate supply curve becomes nearly vertical. At this quantity, higher prices for outputs cannot encourage additional output, because even if firms want to expand output, the inputs of labor and machinery in the economy are fully employed. In this example, the vertical line in the exhibit shows that potential GDP occurs at a total output of 9,500. When an economy is operating at its potential GDP, machines and factories are running at capacity, and the unemployment rate is relatively low—at the natural rate of unemployment. For this reason, potential GDP is sometimes also called full-employment GDP    .

The aggregate demand curve

Aggregate demand (AD) refers to the amount of total spending on domestic goods and services in an economy. (Strictly speaking, AD is what economists call total planned expenditure. This distinction will be further explained in the appendix The Expenditure-Output Model . For now, just think of aggregate demand as total spending.) It includes all four components of demand: consumption, investment, government spending, and net exports (exports minus imports). This demand is determined by a number of factors, but one of them is the price level—recall though, that the price level is an index number such as the GDP deflator that measures the average price of the things we buy. The aggregate demand (AD) curve    shows the total spending on domestic goods and services at each price level.

Questions & Answers

If a good is a normal good, which of the following statment is correct
Mhmad Reply
bigman. xarbi
why did nominal GDP rise by morethan real GDP during Q3 of 2020? what accounts for the difference?
Alara Reply
nominal GDP is not adjusted to the inflation, real GDP is adjusted.
Which countries' nominal GDP?
or global GDP? gross world product :) I think that is a relevant detail
nominal GDP use current year in calculation of GDP while real GDP use base year in calculation of GDP,
what is trade
Aqsa Reply
exchange of goods and services
how do u understand real income
lubega Reply
Income that earned by factor of production is called National income
what is trade balance
real income is the income after the adjustment of inflation, we use base year in it's calculation
anyone to shade more light on elasticity demand?
Ashraf Reply
How are the diminishing marginal utility and negatively sloped demand curve related
Siva Reply
what are the types of trade cycle
riziwani Reply
no saving and tax always subtract from NDPmp
Piyush Reply
these are not part of national income
how so?
but it was given
tax always subtracted from?
tax are always subtracted from what?
keynesian consumption function explain and function
Abdullah Reply
is saving and direct taxes part of income method?
then where should it belong?
what is the rules of macroeconomics
Amadou Reply
Q1. Discuss the comparative analysis of different economic systems which are prevalent around the world. Give detail examples of different countries where different economic systems are in operation. Also discuss how these countries solve the three basic economic problems of what, how and for whom to produce.
Sami Reply
as interest rates increase what happens to planned investment and aggregate expenditures
Patrick Reply
what is applied economic
Micheal Reply
what is the Demand curve
how does one analyze a market where both demand and supply shift
Reymark Reply
explain and justify the effect of the event to the demand and supply for direction then apply the elasticity concepts for extent , support with diagrams
objective of macro economic
saroj Reply

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Source:  OpenStax, Macroeconomics. OpenStax CNX. Jun 16, 2014 Download for free at http://legacy.cnx.org/content/col11626/1.10
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